Correction in housing expected: Former treasurer Peter Costello

Australia’s former and longest serving treasurer, Peter Costello (serving 1996-2007), has outlined that he believes the rampant house price escalation experienced during the pandemic will ease in the next year, as interest rates rise.

Speaking at the (delayed) 2021 Connective Conference in the Sunshine Coast last week, the former treasurer was asked what levers the government could pull to improve deteriorating housing affordability.

While Mr Costello acknowledged that a common solution put forward to addressing affordability focuses on changing property taxation, such as removing negative gearing, he suggested that such a move made by Paul Keating in the 1980s saw “rents [go] through the ceiling [and they] reversed it very quickly”.

“And I think that’s what would really happen [if it were to be removed],” he added.

When asked by broker delegates whether the government should wind back tax deductions for investors owning multiple properties to reduce demand – for example, by repealing the capital gains tax (CGT) concession – Mr Costello responded: “I was the person who introduced the CGT concession so do you think that I think it should be abolished? Erm, no.”

He added that if houses were to come into the full capital gains system, then under tax laws, there should be tax deductibility of interest. “The asset’s either in for both purposes or out for both purposes,” he said.

“We’ve said no tax deductibility on your interest rate payments, and in return, the capital gain will only be taxed at 50 per cent. Personally, I think it’s fair, because I agree with the guy who introduced it.

“So I think, if you’re really worried about housing affordability, you can boost supply or you can reduce demand. And, of course, one of the reasons why demand has been very strong in Australia, is that we have had (up until the pandemic) a very high immigration rate. Now that’s basically stopped over the last two years, and I would expect you will shortly see – once you get off these 0.10 per cent cash interest rates – a correction in the housing market.”

‘We’re going to have to sober up’

He noted home buyers would soon start feeling the impacts of the tightening of monetary policy after having experienced 12 years of rate reductions.

Quoting former chairman of the US Federal Reserve Bank William McChesney Martin, Mr Costello said: “The job of a central banker is to take away the punchbowl just as the party gets going…

“After the party has started, there’s no point taking away the punchbowl then; we’re all going to suffer the hangover,” Mr Costello continued.

“Central bankers are supposed to be stern guys, they worry about the hangover. They worry about what it’s going to be like tomorrow and they take away the punchbowl. 

“Well, the punchbowl has been there for a long time; the [cash] interest rate is at 0.1 per cent, money creation is $460 billion, and we know that we’re going to have to sober up. We’re going to have to sober up because inflation is now on the rise… and the response to rising inflation will be interest rate rises.”

Mr Costello revealed that he believed the central bank forecasts on inflation had “understated the inflation risk”.

“[They]’ve been consistently underestimating the path of inflation… The [Reserve] bank still thinks it’s going to come back and that we don’t have to raise interest rates now because even though we’re outside the 3 per cent mark, it’s going to come back, it will come back sometime around 2022,” Mr Costello said.

“This is the only thing that is obsessing financial markets at the moment. Is the inflation rise temporary? Or is it permanent? Has it just gone up and it’s going to correct itself? Or has the genie escaped from the bottle requiring interest rate rises to knock it back in? 

“Now, when I look at the figures for inflation, I can’t see how it’s going to start falling... inflation has gone up because of the supply chain bottlenecks.

“After those supply chain issues are fixed, prices will come back.

“I think inflation is there, most definitely. And I think the response is going to be rising interest rates.”

He estimated that the central bank will wait until the consumer price index statistics are released on 27 April and 27 July before making a decision on hiking rates. 

“If either of them show that rather than coming back inflation has established itself above 3-3.5 per cent, there will be interest rate rises. And since the market believes that they’re going to be interest rate rises anyway (even if the bank doesn’t), the market has already started to move,” Mr Costello said.

So there’s going to have to be a tightening of monetary policy.”

On the election

Looking forward, Mr Costello noted that there were several “headwinds” economically, including international supply-chain issues and the escalating Russia-Ukraine conflict.

However, he said that in times of uncertainty and “elevated risk”, voters may choose to stick with the status quo for some stability.

“It’s not as easy as the betting markets think it’s going to be for Albanese. It’s still a hard road and I think things are going to tighten up over the next 12 weeks. It may even be that as things get more difficult internationally and economically that will suit the government,” Mr Costello said.

“I always felt in 2007, after doing 10 surplus budgets, after paying off Commonwealth debt, after getting unemployment to 4 per cent, after rising wages… that the gratefulness of the Australian electorate was to throw us out of office…I think if there had been more risk around, it would have suited us a little bit better.

“So I’m not entirely sure that the elevation of risk will work against the government. It may actually work in their favour. The one thing I’ll promise you is: it’s going to be a great ride. It’ll be an interesting night [on election night]. 

“But, whoever wins, I can only see headwinds. I can see headwinds on monetary policy, I can see it in relation to budget policy. I can see it in relation to the international system. Headwinds. 

“It may be the time just to take a little bit of risk off the table, for those of you who are thinking about things in that way.”

[Related: ‘It’s always hard to buy your first home’: Scott Morrison]